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Price Stability and Monetary Policy Effectiveness when Nominal Interest Rates are Bounded at Zero

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Author Info
Günter Coenen (European Central Bank)
Athanasios Orphanides (Board of Governors of the Federal Reserve System)
Volker Wieland (Goethe University of Frankfurt)

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Abstract

This paper employs stochastic simulations of a small structural rational expectations model to investigate the consequences of the zero bound on nominal interest rates. We find that if the economy is subject to stochastic shocks similar in magnitude to those experienced in the United States over the 1980s and 1990s, the consequences of the zero bound are negligible for target inflation rates as low as 2 percent. However, the effects of the constraint are non-linear with respect to the inflation target and produce a quantitatively significant deterioration of the performance of the economy with targets between 0 and 1 percent. The variability of output increases significantly and that of inflation also rises somewhat. Also, we show that the asymmetry of the policy ineffectiveness induced by the zero bound generates a non-vertical long-run Phillips curve. Average output falls increasingly short of potential with lower inflation targets.

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Publisher Info
Article provided by Berkeley Electronic Press in its journal Advances in Macroeconomics.

Volume (Year): 4 (2004)
Issue (Month): 1 ()
Pages: 1187-1187
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Handle: RePEc:bep:macadv:v:4:y:2004:i:1:p:1187-1187

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Related research
Keywords: inflation targeting price stability monetary policy rules liquidity trap

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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